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An Inquiry Into the Nature and Causes of the Wealth of Nations
By: Adam Smith
Major Topic: Economics
Minor Topic: Politics

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         Chapter Two: On Money as Stock and On Banking

         In the same way that all income to an individual can be broken down into wages, rent and profit, the national income can be broken down into the sum of all wages, rents and profits into the national wage income, the national rent income and the national profit income. Furthermore just as an individual distinguishes between gross income and net income it is important to consider these distinctions in the national income. Real wealth is always and in every case relative to the net income, not the gross income.

         Therefore the cost of maintaining fixed capital ought not be included in the national net income.

         Circulating capital needs to be considered differently at the national level than at the individual level. For the provisions, materials and finished work which an individual uses to make his profit and are not consumed are only part of his income if he makes a profit; but are always, from the point of view of the nation, an increase in the fixed capital or consumption stock of the other people who have purchased them.

         The first part of circulating capital, money, and fixed capital are very similar in three ways: (1) both require a certain expense to set up and maintain. This expense is deducted from the national wealth. (2) The wealth of society is made up not of the equipment or tools of construction nor of the money to buy things (these are only the parts of the great wheel that turns society) rather wealth is made up of the actual stuff that is needed for the necessities, conveniences and amusements of life. (3) Any savings in the setting up and supporting of fixed capital and/or money can be considered a net increase in the income of the society.

         One such savings was the introduction of paper money which made it much easier to do business. However the issuing of bills led to distrust with distance from the issuing bank. Eventually interbank cash accounts were established and commerce spread. However banks needed to keep a certain amount of precious metals to cover any withdrawals. The proportion of precious metal reserves to bills had to be high enough to cover demands and losses from defaults. One way the banks protected themselves was to demand frequent and regular payments from debtors. In this way they were (hopefully) never short of money.

         This demand by banks garnered them two other benefits: (1) it allowed bankers to form accurate estimations of their debtor's characters and weed out the troublesome ones without much investigative expense. (2) It allowed the bankers to be sure that they did not issue more bills than the country could use. (if many debtors were having trouble maintaining frequent and regular payments it was a sign that they were having trouble getting the precious metal needed to pay back the bank – therefore there were probably too many notes in circulation and the bank had to cut back on lending.)

         Banks provide a great benefit for the nation. But it comes not from increasing the capital of the country rather the benefit comes from making a larger portion of that capital active and productive. However there are some additional risks that can damage the economy as a result of banks and the issuance of paper money. For example the unskilful use of or handling of the paper money and more significantly an unsuccessful war in which the enemy gets a hold of the underlying precious metal that the paper money represents.

         The author believes that large denominations convenience the big dealers and endanger the average person. On the other hand small denominations convenience the average person and inconvenience the big dealers and leads to many small time bankers that are ill trained or criminal.

         Further it should be said that an increase in paper money, by increasing the quantity will diminish the value and will naturally lead to higher prices in terms of money.

         If Bankers are only allowed to issue notes up to a certain limit and if they agree to be obliged to meet immediately the unconditional payment of such bank notes then the public good will be satisfied and in all other things banks should be free. Free competition among banks will further advantage the public.


         Chapter Three: On the Saving Up of Capital and On Productive and Unproductive Labor

         There are two kinds of labor: productive and unproductive. Productive labor adds some value to the object of labor. Unproductive labor does not add any value to that which is worked on. Workers in factories are an example of productive labor; menial and public servants, the sovereign, soldiers, churchmen, lawyers, doctors, actors and singers are examples of unproductive labor. Productive labor is usually not an expense for it generate a profit. Unproductive labor is always an expense because it does not generate a profit. A man can grow rich with productive labor; but he will grow poor with unproductive labor. Unproductive labor does have a value and does deserve its just remuneration – the author only wishes to say that it adds nothing in terms of value to any value that is already in its work. In some cases unproductive work merely returns to its original value as a doctor returns a patient to health; sometimes a value is protected as in the deterrence value of soldiers; and sometimes there is not any lasting value only consumption value as in the performance of a play.

         The whole of a country's production is ultimately for the sake of consumption. But when it first comes from the land or from the laborer it can be divided into two parts: (1) the larger part is destined to replace capital such as the wages of productive labor and the provisions, materials or finished products of capital; or (2) as a revenue of profit for stock or as a revenue of rent for land.

         The first part is the part that provides a revenue to labor. If the labor is productive it is expected to replace itself; if the labor is unproductive the capital becomes part of the stock for immediate consumption. But in every case unproductive labor is not put into action until all productive labor is first employed.

         The rent of land and the surplus profit of stock, above what is needed to supply productive labor that is the revenue of stock, are the sources from which unproductive labor earns its wage. The proportion of productive to unproductive labor depends on the proportion of a country's production destined for replacing capital and that destined for revenue. The larger the first in proportion to the second; the richer the country. The author gives several examples of how rent must go up and profits down over time but in each case the produce of land necessarily increases far more than the rent increases and the total amount of stock increases far more than the rate of profit decreases such that, with less profit per stock unit, more revenue is generated from the far larger increase in total stock.

         Interestingly, the proportion of the stock destined for capital replacement to revenue seems to determine the character of the inhabitants. The larger the fund for replacing capital; the more industrious, sober and thriving the population. The scantier the fund for replacing capital; the more idle, dissolute and poor the population. One can see the difference by comparing a factory town with a town dominated by a great and noble lord.

         The proportion between these two funds, between capital as replacement for capital and capital as revenue, establishes the proportion of industry to idleness. As capital increases so do industry, the number of productive laborers, the annual production and produce of the nation, and the real wealth and revenue of the people; as capital decreases so do all of the aforementioned.

         Capital is increased through frugality and decreased through prodigality and/or wrongdoing. In the same way that an individual may increase his capital by saving his income and then investing it or lending it, a nation may increase its capital by the combined savings of all its citizens. It is frugality not industry that is the cause of increased capital. Money spent on consumption is not productive for it returns nothing after being spent. Money saved for increased production will generate more money and increased wealth as all production is eventually and ultimately destined for consumption. The difference is only whether there will be more consumption later or the same (or less consumption as in the case of reducing the fund used to replace capital).

         The quantity of money must increase as the value of the annual produce increases because the purpose of money is to circulate the produce of the nation. Precious metals will naturally be attracted to a growing economy and will flee from a shrinking economy. The increase in gold or silver in rich countries is a symptom of wealth not the cause of wealth.

         Never has a country ever been ruined by private prodigality but there have been instances of countries being ruined by public prodigality. This is always a possibility since almost the whole of public revenue is used to maintain unproductive labor. Such things as the monarch's court, ecclesiastical establishments and the armed forces if expanded too much will take away from the capital needed to replace production; this will lead to less and less production and over time will ruin the country.

         In England the lavishness and excess of government has retarded the natural progress of improvement but it has not stopped it. Since England has not had a frugal government, its people have never generally held that virtue either. Therefore it seems the highest level of hypocrisy that the leaders should claim to watch over the affairs of private people.

         As consumption is concerned, there are somethings that increase the opulence of a country more than others. In general the more durable the item the longer it can last and therefore the more of them will exist over time.


         Chapter Four: On Stock Lent at Interest

         Stock lent at interest should always be considered capital. Certainly the lender thinks of it as capital for he wants a return in interest. If the borrower considers it capital he will invest it in order to make more money; however if it is considered as consumption stock, the borrower will soon find himself in financial difficulty.

         All loans are usually made in money and paid back in money but what is sought is the goods or labor that can be had with the money. This fact creates a certain multiplication of demand. Money quickly travels between people therefore as one person lends or trades the money for goods the second, who received the money, then takes the role of the first and also lends or trades the money for yet more goods. This chain usually increase with more wealth and greater improvement in the society. But as the money lent increase the rate of interest is reduced for the same reasons as the profit rate is reduced with more capital: competition between lenders will lower the interest rate in wealthy countries just as competition between stockholders will lower the rate of return in countries with high concentrations of stock.

         There is a common misconception that lowering the value of precious metals will lower the rate of interest – this is impossible since the rate of interest is not connected to the value of precious metal but rather it is connected to the real wealth of the nation and more precisely the number of lenders in the nation.

         Jurisdictions which prevent lending at interest will not in actuality prevent lending at interest rather such laws increase the minimum profitable rate of interest to exorbitant heights due to the added pressures and uncertainties. Ideally the law should prevent exorbitant usury by setting a maximum rate of interest that is slightly higher than the actual free rate of interest. In such a way sober and more trustworthy people will be preferred to rascals and scoundrels.


         Chapter Five: On the Different Employments of Capital

         Capital may vary in its productive multiplier. There are four different ways to use capital: (1) to produce raw materials; (2) to transform raw materials into usable final products (3) to transport raw material or final products; and (4) to divide or bundle the raw material or finished products into quantities that more and more people can afford. Each builds on the previous one adding value and cost.

         A country that does not have enough capital to satisfy the needs of all four uses of capital has not yet reached an opulence level commensurate to its destiny. To try to do so prematurely with less than enough capital is to court failure. A country like an individual must save up its capital and can only make use of that capital that is available for workers. Too much capital and not enough labor will find the capital unproductive.

         All wholesale trade falls into three categories: (1) home trade – trade within the country for resale; (2) foreign trade – the purchase of foreign goods for resale at home; and (3) carrying trade – the transport of foreign goods for foreigners.

         Capital involved in all three will generate a revenue but home trade provides the most replenishment of capital and support for productive labor in the home country: at both ends of the trade. Foreign trade will replenish the capital and support the labor of both the home country and the foreign country involved in the trade. The carrying trade will not support any home country industry but it will provide an income to the stockholders.

         The purpose of political economy is to increase the wealth of the nation – for in the wealth of the nation lies the power of the nation. But it is often noted that home trade is more beneficial than foreign or carrying trade and therefore the later two ought to be forbidden or at least discouraged. This is a grave mistake because capital in excess of what the home trade can use is unproductive if it cannot go to foreign countries in search of a return. The accumulation of capital necessarily reduces its return and as the return drops it is natural and good for it to seek new ways to make a return. Therefore the more opulent the country the more foreign trade there should be and the more carrying trade too. A small or non-existing carrying trade is an indication that the country has not developed a high concentration of capital.


         The following two books will try to answer why some countries would support the industry of the towns over that of the countryside with the result that the countryside is not fully cultivated and yet some countries find it more to their advantage to use their capital in foreign carrying trades than in domestic field cultivation.


Added on: 2010-05-29 07:04:48
Text Crawl by: James Jeff McLaren
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